Money Matters: Forgo flash car and land on your feet

By MARY HOLM

Q. I have recently been made redundant (at 40 years old with two young children) but have been lucky enough to find a new job paying $50,000 a year.

My redundancy (including my super contributions) comes to $32,000, and we have about $10,000 left to repay on our fixed-rate mortgage.

My old job provided a car which my new job does not, so we are looking to buy a decent car.

What do you believe are my options: pay off the mortgage? Reinvest the redundancy? Buy a new car on HP?

It seems we could be debt-free immediately, but should I use up the redundancy or keep it as the start of our retirement fund?

A. Redundancy can be the best thing that ever happened - financially at least - to many people. And luckily, you are one of them.

Getting $32,000 in a lump sum can really put you on your feet. If, that is, you have the courage to cope with one thing that many people can't - being seen in an inferior car.

Your work car was probably fairly posh. But if you own your own expensive, or even mid-priced, car it's a big money drain. Even as it sits in the garage, its value can drop by thousands of dollars a year.

I'm not suggesting you buy such a bomb that you're always spending money on repairs. But these days you can get pretty reliable transport for several thousand dollars.

My first suggestion to you, then, is to buy a car for, say, $10,000. Pay cash. That might give you more bargaining power and you avoid paying the pretty high interest that comes with car loans.

Next, I would look into repaying your mortgage. Your goal of being debt-free is a good one.

The trouble is that there's usually a penalty if you repay a fixed-rate mortgage early.

Those penalties vary. It might be worth paying it anyway. But there is another option.

Let's say the fixed-rate period ends 18 months from now. Put $10,000 - or whatever is needed - in a term deposit that matures in 18 months.

Repay the mortgage on the first day the early repayment penalty no longer applies.

Meanwhile, you will have earned interest in the term deposit. Unless you've been really lucky with timing, it won't be as high as the interest you're paying on your mortgage - especially after tax. But the difference shouldn't be huge.

Basically, you need to compare that difference with the early repayment penalty, and go with whichever is smaller.

There are some timing issues. Paying a dollar now costs more than paying one later. So the penalty now is more costly than making up the difference over the months ahead.

But, given that we're dealing with a relatively small amount of money over quite a short period, none of that will amount to much.

If it confuses you, don't bother about it.

In any case, your mortgage lender should be willing to help you work out which option is better for you.

All of this will leave you with about $12,000 to put into a retirement fund. That's a good start.

Once you've paid off your mortgage, keep putting the equivalent of your mortgage payments into this fund, plus other savings, and you could have a healthy amount stashed away by retirement

So there you have it: a car, no mortgage, and retirement money.

It should be worth a few bomby-car blues.

If your mates give you a hard time about your new wheels, tell them I made you buy them - and that you'll end up richer for it.

I write to you as a member of the NZ Statistics Police.

Although the position is honorary and self-appointed, I try to take it seriously, given the potential damage that can be done by people flogging dodgy numbers.

In your column of September 23, you quoted a fund manager as saying that "$1 invested in shares in 1956 would be worth $207, including reinvested dividends, in 1999. But had you invested it in residential property it would be worth only $25."

These figures imply returns over the period of 13.2 per cent a year for NZ shares and only 7.8 per cent a year for residential property. This comparison is wrong, wrong, wrong.

The quoted return from shares included dividends, whereas the return from houses does not include rentals.

Fund managers have been using this sort of statistical sleight of hand on and off for years.

It certainly is easy to look tall if you stand by a short person - better still if the other person is lying down.

I contracted economics consulting group Infometrics to prepare an index of NZ house prices without rents.

Its figures, from 1961 to 1999, reveal a return of 8.7 per cent a year - close enough to the figures you quote.

But rental income less expenses probably adds at least 3 to 5 per cent a year to this figure.

Looked at another way, if we calculate a capital index for NZ shares, that is also excluding dividends, the return over 1956-99 is only 6.2 per cent a year - less than property when calculated on the same basis.

I'm not saying houses are better than shares, just that an informed discussion of the matter depends on having good data.

As this is your first offence, I will let you off with a warning. But be careful about accepting free statistics from fund managers.

As you know there are no free lunches in this world.

Your crusade to persuade New Zealanders to invest in assets other than residential housing has merit in its own right.

You don't need to use dodgy stats.

A. I've just whipped out and hired my favourite lawyer, and she says I'm not guilty.

But honesty forces me to admit that had this gone to court an interesting battle might have ensued.

Here's how my case might have gone: Even though I said "invested in residential property," I had in mind investing in your own house, not a property that is rented out. That means there is no rental income.

Okay, officer, I'll concede that when you own your home, you receive the equivalent of rental income, in that you don't have to spend money on shelter.

Still, I think many people choose between:

*Owning a cheaper home and investing savings elsewhere, and

*Owning a more expensive home, which they regard as an investment.

For them, the comparison I gave was apt, not "wrong, wrong, wrong."

Your case: Readers might have thought I meant rental property, in which case rent should, of course, be included.

When rent is included, the returns on shares and property are much closer.

Me again: The trouble with research that includes rent is that everyone disagrees about what data to use. It's not like shares, where it's obvious that you use a sharemarket index.

With variable data, you get variable conclusions. I've seen findings go one way and the other.

Just as fund managers may introduce a bias into their research, so certainly do real estate firms pushing the sale of rental property.

And in my experience, the latter play faster and freer with the facts.

Perhaps we could agree that the numbers I used aren't good if you're looking at rental property.

But even when you do include rent in the calculations, shares tend over time to do better, especially these days.

I can't resist saying, too, that others in the NZ Stats Police might be a bit cross with you for introducing into the debate a NZ share index that excludes dividends, and then comparing that with property without rental income.

Surely the main point of your letter is that we ought to look at whole returns, including ongoing income and capital gains.

It's particularly unfair to look at just capital gains on New Zealand shares, which are notable for their unusually high dividends.

Now let's hear from a kindred spirit of yours.

Q. Having retired three years ago and now deriving most of my income from investments in both property and shares, I find your column very interesting and generally agree with your good sense and advice.

However, although you have in past columns disclaimed an anti-property bias, it does occasionally show itself, as in the quote from Armstrong Jones, where it compares shares, property and bank deposits.

The comparison is made where all share dividends are reinvested. To compare apples with apples you would have to allow a situation where all rents were also reinvested.

This, I am certain, would show property in a much more favourable light.

Other factors are also relevant.

If the original capital and subsequent reinvested rents were leveraged by a mortgage, as is usually the case, the gains could have been even greater.

A. Firstly, about this "bias:"

I've owned rental property in the past, and sometimes done pretty well from it. Some of my best friends still do own it, and sometimes still do well from it.

It can be a good investment. But letters to this column and discussions with all sorts of people over the years have shown that it's a riskier investment than many New Zealanders realise.

Unlike fund managers, real estate brokers and various other characters, I don't get any richer by being for or against property.

My opinions come just from what I see.

Your next point we've already discussed above.

But your third point, about mortgages, bothers me a bit.

You talk about comparing apples with apples. Whenever we compare investments, we should either look at all of them leveraged (or geared) with a mortgage, or without.

If you add a mortgage, it simply ups the ante.

If your investment does well, the leveraging will make it even better. If it does badly, leveraging can leave you in deep trouble.

This applies whether you're investing in property, shares or truffles.

It's true that New Zealanders are more inclined to borrow for a property investment than a share one. That's largely because property is seen as less risky to start with.

But, especially in recent times, it hasn't been at all clear to me that investing in a single rental property is less risky than in, say, a world share fund.

Mary Holm is a freelance journalist and author of Investing Made Simple.

If you have a question for her, send it to e-mail: maryh@journalist.com or Money Matters, Business Herald, PO Box 32, Auckland.

Letters should not exceed 200 words. We won't publish your name, but please provide it and a (preferably daytime) phone number in case we need more information.

Mary cannot answer all questions, correspond directly with readers, or give financial advice outside the column.